As individuals cautiously dip back into the investing pool, it's important that we all take steps to protect our portfolios and to maximize the chance of reaching our financial goals. As we talk with our customers, we focus on seven key principles that should be incorporated into every investment plan.
Know your "number"
Your "number" is the amount of cash or cash equivalent investments that you need to feel comfortable sticking to your long-term investment plan. Difficult market conditions often lead to fear-based and emotional investment decisions. However, having enough money specifically set aside to cover 12 months of living expenses can help reinforce your ability to ride out cyclical market downturns without losing sight of your long-term plan.
Your time horizon makes all the difference
Your time horizon incorporates the multiple timelines for each of your investment goals. All things being equal, you can typically afford to take on more risk if you have a longer time horizon, since you'll have more time to accumulate savings and replenish any losses. The shorter your time horizon, the fewer risky investments you should hold in your portfolio. As a general rule of thumb, if you're planning to tap into your investments within five years, you probably shouldn't have meaningful exposure to riskier asset classes such as stocks.
Discover the mix of investments suitable for your personal circumstance
You probably don't have just one financial goal you have several. Each of these goals whether it's funding your child's college tuition, building a sizable nest egg, or leaving behind a charitable legacy should be considered individually. The idea is to create a comprehensive investment strategy that considers your various financial goals, appetite for risk, income needs, time horizons, tax concerns, existing assets, and family situation.
Strive for consistent returns through diversification
Portfolios that generate consistent returns are likely to increase your wealth more than portfolios that produce more volatile returns. To help minimize volatility, make sure your long-term asset allocation is well diversified by combining assets whose returns do not move up or down in lockstep with each other. For example, you may want to consider adding investments such as commodities, which tend to perform better when more traditional investments such as stocks and bonds do poorly.
Risk is far more than volatility
Risk is typically discussed in terms of price instability as it relates to investment type, but in real life, risk exists in a variety of forms. Different types of risk exposure include the speed in which you're able to turn assets into cash; uncertainty associated with any legal, regulatory, and accounting issues in relation to your investments; and the risk of unusual events derailing your investment plan, among others. Since each investor has unique constraints, you should take inventory of your major risks to determine how to effectively spread risk across a diversified portfolio.
Due diligence goes beyond historical returns
As many investors have found during the current challenging market conditions, historical returns have very little predictive value for future performance. When selecting portfolio managers the people responsible for investing the assets of various funds you may want to consider the manager's potential for future success rather than focus solely on historical returns. You may find that some qualitative issues such as the manager's investment process, integrity, experience, service-quality, compensation and company culture trump quantitative factors.
Ensure your portfolio is adequately monitored and rebalanced
Rebalancing your portfolio on a regular basis is critical. Many investors lack disciplined rebalancing plans and exacerbate their misbalanced portfolios by adding to asset classes that have been going up and selling asset classes that have been going down. To avoid this, make sure your portfolio is rebalanced at least once a year or when your portfolio's asset mix has moved out of line with your long-term investment strategy.
Changes in the market over the past several months have reminded us that successful investment management does not come from chasing hot stocks in the hopes of overnight riches, but rather, from planning, discipline, and ongoing maintenance. By following the seven key investment principles outlined here, you and your investment professional can work together to create a plan that truly addresses your personal needs and helps you reach your goals.
David Hehn is the regional manager of Wells Fargo Private Bank in northern Nevada.